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Figuring out how to start paying back your debt can be confusing. You could pay back your debt as agreed, but that could end up costing you a lot in interest. You could attend credit counseling to see what options you have so you can pay back your debt in the most efficient way possible, or you could simply consolidate your debt and start paying off the debt consolidation loan. We cover the scenarios in which an individual should consider debt consolidation or credit counseling.
What is Debt Consolidation? How Does It Work?
Debt consolidation is the act of taking out a large loan and then using the proceeds from the loan to pay off your other debts. This allows you to have fewer payments to worry about each month while hopefully reducing the amount of interest you'll pay. Most people focus on consolidating unsecured debt, such as credit card debt and payday loans, because of the higher interest rates that are charged on these types of debt.
When you consolidate your debt, most people choose one of two options. The first is a personal loan, which is usually repaid over a period of one to seven years. The fixed time period helps people pay off debt faster than a revolving credit line, which usually only requires minimum payments. The interest rates on personal loans range from 5% to 36%, but even someone with an excellent FICO credit score may only receive an interest rate between 10.3% and 12.5%.
The other popular option is getting a credit card with a promotional 0% annual percentage rate (APR) on balance transfers. These offers usually last from just a few months to as long as 21 months, giving a borrower a chance to repay their debt without paying any interest at all. You may have to pay a balance transfer fee. Some cards don't charge these fees, but others will charge 3% to 5% of the balance transferred. If you cannot pay back the amount in full by the time the promotional period ends, you'll have to pay the standard interest rate or transfer the remaining balance to a card with another promotional offer.
How Does Credit Counseling Work?
Credit counseling requires speaking with a credit counselor to discuss your financial situation to find potential methods to solve your debt problems. Many credit counselors want to help you figure out the most reasonable way to solve your debt problems. In order to advise you on your debt situation, you'll need to provide the credit counselor with information about the debt you owe, your income, expenses and any assets you may own that could be used to help pay off the debt.
Once a credit counselor analyzes your financial situation, they may suggest a variety of solutions including budgeting, debt management plans, debt consolidation, debt settlement or even bankruptcy in certain cases. Credit counselors may charge fees for some of their offerings, but many services can be provided for free or for a low fee, especially if you work with a National Foundation for Credit Counseling certified consumer credit counselor.
Which Makes More Sense: Debt Consolidation or Credit Counseling?
Debt consolidation is the clear winner for people who aren't struggling to meet their debt obligations but simply want to save money on interest. For instance, if you just have a couple of credit card bills but you have plenty of disposable income to make extra payments each month, consolidating your credit card debt to a personal loan with a lower interest rate could save you money on interest and allow you to pay off your debt faster.
On the other hand, credit counseling usually makes more sense if you're struggling with your debt. If you can barely make the minimum payments each month (or can't make them at all), credit counseling can help you understand your financial situation and provide options for how to fix your debt problem. You may also be a great candidate for credit counseling if you are simply overwhelmed by your finances and don't know where to start.
You may think you need to decide between credit counseling and debt consolidation. Thankfully, that may not always be the case. Many people fall somewhere in between. They know they have a debt problem and also know that it can be fixed with a bit of hard work. Since credit counseling offers many services to help solve debt problems, you may be able to get benefits from both credit counseling and debt consolidation.
Credit counseling can help you understand your finances, teach you to budget and give you options for how best to pay down your debt. One of those options could very well be debt consolidation. Before you agree to a plan, ask whether the credit counselors are compensated based on the actions you take from their suggestions. Ask questions about their suggestions, and compare them to other offers. Doing so will help you make sure the counselor is truly looking out for your best interests, not theirs.